The Financial Products That Blew Up The Global Economy Are Sliding Into The Shadow Banking System

The products that threw banks around the world into free-fall,
dragging the global economy down with them, are not gone —
they're just moving into hedge funds,
Bloomberg reports.

Because hedge funds are far less regulated than your average
bank, they're considered a part of the shadow banking system.

Additionally, because hedge funds are far less regulated than
your average bank, they can pick up the assets that governments
are forcing banks to get rid of — things like distressed
corporate debt, mortgage backed securities, and all sorts of fun
credit derivatives.

The thing is, all of this has been happening relatively slowly.
Bloomberg says hedge funds have only picked up $108 billion of
these assets since 2009, which is nothing compared to what Wall
Street has on its balance sheet. JP
Morgan alone had an average of $413.4 billion in trading
assets in Q1, says the report.

That said, however, for hedge funds, slow and stead will likely
win the race.

They attracted $41.4 billion from pension plans, wealthy
individuals and other investors in 2012, the most since 2007,
after a combined $57.4 billion of net inflows in the two previous
years, HFR data show. The three-year total was a record.

Hedge funds focusing on fixed-income arbitrage boosted returns by
51 percent last year, while fixed-income, currencies and
commodities-trading revenue at the nine largest banks rose 14
percent, excluding accounting charges, according to data compiled
by Bloomberg.

The strategy, once employed by Long-Term Capital Management LP,
focuses on exploiting pricing inconsistencies between assets
rather than making bets on the market’s direction at a time when
Berkshire Hathaway Inc. Chairman and CEO Warren Buffett
and Goldman
Sachs President Gary
Cohn are predicting losses for fixed-income investors when
interest rates rise.

Things ended very badly for Long-Term Capital Management, but
hey, it's a new day right?

Bloomberg specifically mentions three hedge funds that are really
leading this march, BlueCrest, Pine River Capital and Millennium
Management LLC. Together they have over $67 billion in assets.

You can bet governments around the world are happy about this. It
means risk is being transferred away from systemically important
institutions.